The Duchess asks Sancho whether he ever delivered the message to Dulcinea, and whether he completely invented her reply. Sancho paces around the room and replies that his master is insane, though he often speaks very intelligently, so Sancho sometimes makes him believe certain things that aren’t true. As an example, he describes his enchanting of Dulcinea.
Sancho understands that Quixote has a separate, imagined view of the world, and he thinks that he can add a little unreality to it at will. He doesn’t realize that the imagined view has a delicate logic that shouldn’t be disturbed.
The Duchess implies that someone who obeys a madman must be mad himself, and Sancho explains that he is too fond of his master to abandon him. The Duchess tells Sancho that she knows for certain that the peasant girl on the donkey truly was Dulcinea, and she was definitely enchanted. He is relieved to hear it, because he doesn’t want to have the power to enchant people as he did the peasant girl, and he doesn’t want to think that he tricked his master. He also describes to her the adventure of the Cave of Montesinos. In a little while, Sancho leaves to take a nap.
Sancho’s reply conflates madness and fondness. In a way, his love for his master is a kind of madness, because it signifies imaginative acceptance of Quixote’s worldview. But Sancho’s realism makes it difficult for him to see it as the only reality. He is relieved to hear from a Duchess that Dulcinea is truly enchanted, because it helps him make the leap of faith.